The year has begun with a continuation of the bullish optimism in equities. The new mood rewarding economically-sensitive market segments began with the big post-election rally – which was partly due to simply removing the election uncertainty and partly due to the “Trump Bump” and an expectation of a more business-friendly environment. Investors are playing a bit of wait-and-see regarding President Trump’s initial executive orders. Last week ended with a strong employment report and an executive order seeking to take the shackles off the banking industry (including dismantling of the Dodd-Frank Act and delay/review of the DOL Fiduciary Rule), which sent the Financial sector surging and led the Dow to close back above 20,000 and the NASDAQ Composite to new record highs, while the S&P500 struggles to breakout above the 2,300 level.
No doubt, the new Administration is shaking things up, as promised…and the left is pushing back hard, as promised. Nevertheless, I believe economic fundamentals are positive with a favorable environment for equities globally – especially fundamentals-based portfolios like Sabrient’s. I also like the prospects for small caps, European, and Japan.
In this periodic update, I give my view of the current market environment, offer a technical analysis of the S&P 500 chart, review Sabrient’s weekly fundamentals-based SectorCast rankings of the ten U.S. business sectors, and then offer up some actionable ETF trading ideas. Overall, our sector rankings still look bullish, and the sector rotation model continues to suggest a bullish stance. Read on….
Market overview:
On January 17, we launched our ninth annual Baker’s Dozen top stocks list for 2017. I was on the road continuously over the past four weeks speaking with financial advisors across the country, and they are heartened to see that the investment community seems to have abandoned its short-sighted news-driven trading behavior in favor of a return to normal fundamental-based investing. Today, investors appear to be back in alignment with the expectations of the analyst community, which is more typical behavior. As a result, sector correlations have fallen, dispersion has increased, and small caps are outperforming, meaning that investors are picking their spots rather than engaging in narrow, risk-on/risk-off, fear-based trading.
At Sabrient, we believe in GARP (growth at a reasonable price). After all, that is why someone starts a business or invests in one in the first place, i.e., because they believe that the business will grow its earnings over time. In our view, long-term investing (as opposed to speculation or short-term trading) is all about GARP. Investors never stray from this for very long. And indeed, we already have seen a marked boost in the performance of our portfolios, which are based on our bottom-up, numbers-driven, fundamentals-based, forward-looking quantitative model. At its core, our portfolio construction approach seeks an average Forward PEG (for the next 12 months) that is well under the benchmark.
No doubt, many fundamentals- and valuation-based stock pickers (including virtually all the famous billionaire value investors and activist hedge fund managers) struggled during the unfavorable news-driven risk-on/risk-off market conditions that characterized the June 2015 – June 2016 timeframe, and Sabrient was no exception. But this was essentially one 12-month period of underperformance out of eight years of our Baker’s Dozen publication (starting in 2009) – although admittedly it straddled two of our January Baker’s Dozen portfolios and impacted both.
If Wall Street’s consensus view on the outlook for the companies and industries it covers changes substantially, or if fundamentals are ignored (risk-on/risk-off) by investors, then fundamentals-based strategies like ours languish. This is exactly what happened in mid-2015, when China warned of a falling growth rate and currency devaluation, oil prices fell below key thresholds, the Fed telegraphed commencement of a tightening cycle, and the election campaign rhetoric targeted various industries (especially pharma). At the time, our 2015 Baker’s Dozen was well ahead of the S&P 500 performance.
Market conditions became news-driven rather than fundamentals & valuation-driven and only a handful of mega-cap growth stocks out-performed. Fundamentals simply didn’t matter. Growth greatly outperformed value, and the cap-weighted large cap indexes held up far better than the mid and small caps. But after the short-covering rally in mid-February 2016, the market began to broaden away from its narrow leadership, and after the uncertainties of the Brexit vote and the US elections were lifted later in the year, market behavior began to normalize. Capital flowed heavily into value stocks and small caps, with lower correlations among asset classes and sectors (down from the 95% correlations during 2015, falling into the mid-70s) and higher performance dispersion among equities. This is all quite healthy.
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